http://www.ngpharma.com/currentissue/article.asp?art=275451&issue=285

Incentive Compensation Plan Diagnosis in the Pharmaceutical Industry

November 2008

As pharmaceutical companies step up their focus on retaining key sales staff, they are considering ways to leverage variable compensation, such as incentive, reward and recognition programs, as a strategic tool to maximize ROI in top talent and motivate their sales forces to support corporate strategies.

Pharmaceutical companies traditionally have attracted and retained high-performing sales staff through offerings of competitive, total-compensation packages. These packages are usually comprised of base pay, benefits, bonuses and recognition programs – typically contests and awards (C&As). However, in recent years companies have balanced this goal with budgetary constraints by devising variable pay schemes, which account for a larger percentage of compensation, and offer increasing pay for higher performance. For example, across European countries, the proportion of variable pay compared to fixed pay varies by a factor of almost three-fold, thereby influencing the leverage that is achieved from individual bonus schemes in these countries.

Today in the United States, industry emphasis is shifting from recruitment to retention activities. The costly effects of voluntary attrition among sales representatives, which results in recruiting and training costs, lost time in the territory and diminished client relationships, is estimated by the Hay Group to be $100,000 per individual. It’s now more important than ever that pharmaceutical companies take steps to ensure that their existing sales force remains productive, motivated and committed by developing and refining strategic incentive and reward programs. Furthermore, with an overall decrease in the total number of sales representatives, it’s imperative that pharmaceutical firms retain their best sales staff through an on-going process of adjusting variable pay practices. These steps are crucial to enabling the alignment of retention goals with other critical business objectives.

The three major attributes of an Incentive Compensation (IC) plan are to position the company for success, align with corporate and/or brand objectives, and to motivate the sales representatives with a plan that is easy to understand and fair. Today, however, many sales representatives are displeased with their IC plans. Common themes among sales representatives’

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complaints include: the plans are unfair, the plans are too complicated to understand, and it takes too long to receive the bonus payouts.

Incentive Compensation Plan Structure

There are four major elements to total compensation – base salary, benefits, bonuses and C&As. In life sciences in the United States, bonuses and C&As account for about 25 percent of base pay. This percentage increases with higher value and more complex products, i.e. specialty products and medical devices. Bonuses are usually based on four categories of rewards: sales, activity, management by objectives (MBOs) and C&As. Contests tend to be ad hoc and short term, usually less than one year, and used to motivate specific behaviors, such as to increase market share for a specific patient type, protect against generic erosion, or grow sales volume in collaboration with a new sales campaign. Contests can be absolute, such as top 10 in the country or highest in a specific region or state, or variable, such as exceeding a certain performance threshold. Awards typically recognize long-term behavior. C&As, such as President’s Club or Consistent Achievers, can take the form of cash; in-kind, such as points, trips, etc.; or pure recognition. In some cases, awards can be linked to a kicker in the bonus payouts. This can both increase motivation and retention.

Plan structure involves not only defining the right target pay level but also the right pay mix. In fact, determining the right pay mix is as important as the pay level. The higher the variable component of a pay mix, the higher the motivation and revenue growth but also the increased financial risk to the company. This is because the sales representatives can make much higher pay with a higher variable component. The optimum mix of fixed and variable pay will be influenced by the type of product and the market. In the Medical Device industry, sales representatives sell sophisticated and highly expensive medical products and services, for which a pay mix with a lower base salary but higher variable component is preferred. This represents a higher risk/reward to the company. On the other hand, in the pharmaceutical market, a mature product is not impacted as much by representative performance. Companies in these businesses prefer a low-risk mix, which has a lower variable component and therefore limits how much a representative can earn.

Plan Diagnosis

There are four major steps involved in the IC process – diagnosis, design, implement and operate (Figure 1). There is a clear case for plan diagnosis in the pharmaceutical industry today. This is a critical step in the continuous improvement process for IC. In plan diagnosis, there are three key areas that should be analyzed: investigating the technology, understanding the processes, and evaluating the plan itself.

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First, with regards to technology, it is surprising that many pharmaceutical companies are still using homegrown systems, custom-built applications or spreadsheet-based IC tools. Most of these applications are slow and inaccurate, do not provide easy visibility to the business rules of the plan, lack audit trails and version control, do not easily support the complex rules required for new sales force models, and require significant manual entry and ongoing reprogramming. Often it takes four to six weeks after receipt of the data to produce IC reports, and at least an additional 2 weeks for the payouts to be made. These applications create frequent disputes over sales credits and compensation payouts, which are time-consuming and costly to resolve. Additionally, they create an atmosphere of distrust within the sales force that results in shadow accounting, lower morale and higher turnover. Unlike other industries, life sciences companies are not realizing the full benefits of a world-class enterprise IC application, where business rules are quickly configured, complex organizational structures and allocation rules are easily managed, and it only takes a few days to produce IC reports with full access to executive dashboards.

Second, regarding processes, few pharmaceutical companies have actually documented their standard operating procedures (SOPs). Performing a diagnostic on the end-to-end IC process (Figure 2) will clearly identify areas of inefficiencies and time delays. Each individual process is highly complex, often involving manual tasks, e-mail communications and spreadsheet consolidations. Companies rarely have a full audit trail and documentation for all of their IC materials, quality control checks, plan checks and associated approvals. Few companies use automated workflow tools to manage the communications, transfer documents and track authorizations. Enterprise IC software has built-in workflows tools and can integrate with standard business process management applications. The area that may be best managed is the quality controls associated with performance data and report production. Personnel information and eligibility data is the most fragmented because changes to staffing do not get entered into the central human resources (HR) repository quickly enough, resulting in an HR system of record that’s not up-to-date, resulting in information needing to be gathered and then consolidated from multiple sources.

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Third, with regards to evaluating the plan itself, the diagnostic evaluation of IC plans focuses on three areas: inherent issues, plan metrics, and plan bias. This plan diagnostic evaluation follows a methodology, which results in the evaluation of underlying issues and the identification of alternatives to improve the plan design (Figure 3).

Plan Diagnostic Evaluation – Inherent Issues

When IC plans are developed there are various inherent issues associated with the business that are often overlooked. This results in poor plan design.

Products grow at different rates depending on their position in the product life cycle. For example, analyzing one company’s product portfolio revealed that for one product in its early life cycle those territories with higher market share grew faster than territories with lower market share, while two other products that were later in their life cycle grew with the opposite dynamics. However, the company had not realized these differences so quotas had previously been set independent of the territories’ starting market shares. To correct this, quotas had to be modified based on each territory’s initial market share, or a market share/market share change matrix-based plan adopted. In the later case, the bonus amounts were scaled based on the products’ dynamics.

Evaluating performance by geography can identify inherent issues due to variations in local prescribing regulations. However, these are rarely considered when setting quotas. For example, one case showed that territories in the Western United States consistently under-performed,

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while territories in the Eastern United States were consistent high performers. After modifying the quotas to take into consideration the local managed care restrictions, this bias was eliminated.

Plan Diagnostic Evaluation – Plan Metrics

Companies define their plan metrics during plan design, but rarely do they evaluate them during the year or at the end of the years whether the predefined metrics were actually achieved. Key payout metrics are: target payout, average payout, lowest payout, highest payout, percent with no payout, payout at 90th percentile, pay to 10th percentile, and median achievement. This is a critical aspect of plan diagnosis because it provides valuable input to plan design changes – either mid-year or for the following year. Also, most companies have defined corporate performance characteristics that should be followed, such as distribution of achievements and associated payouts.

For example, one company’s diagnostic found that only seven of 69 territories were actually achieving target numbers and receiving bonus payouts. As a result, the company revaluated both its corporate sales forecasts and its overall plan design to ensure better quota accuracy and a more appropriate distribution of achievements.

Plan Diagnostic Evaluation – Plan Bias

When designing IC plans there are two conflicting characteristics – easy to understand verses plan fairness. Performing a plan diagnostic helps to identify any bias in plan design. The information can then be used to reduce plan design bias for the following year.

Typical biases involve historic sales, market potential, market share and growth rates. For example, if a plan diagnostic shows that there is little correlation between territory size and achievement against goal, the plan is fair because there is no bias between starting sales volume and percent achievement. However, if a plan diagnostic shows that bonuses are biased to large territories, the plan is unfair because there is a clear advantage to high sales volume territories.

Another plan diagnostic evaluated the correlation of market share to plan achievement. Despite a five-fold variation in market share, the plan had been well designed and showed no bias due to market share, as each territory had a similar opportunity to achieve (Figure 4).

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Summary

Efficient and consistently accurate execution of the IC deliverables are required for the long-term success of any compensation plan. Without this, the IC plan will be undermined by a lack of trust at all levels of the corporation. Best-in-class compensation provides regular, consistent and accurate reporting at a reasonable cost, with the flexibility to swiftly adapt to changing strategies and tactics. Field sales staff should have rapid access to IC plan reports and executives should be able to access dashboards to easily evaluate performance.

The average lifecycle of a pharmaceutical compensation plan is three years. Many companies consider their plans to be discrete initiatives that either morph or remain stagnant from year to year. Most firms keep the basic structure of their programs consistent from year to year, however they review their plans and make adjustments on an annual basis to meet organizational and company objectives. This represents a process of continual improvement rather than periodic upheaval.

Plan diagnosis is a critical step in the continual evolution required to ensure good plan design. Most companies understand qualitatively the impact of poor plan design, but few recognize the major financial ramifications, including increased turnover, reduced moral, lost selling time, lost competitive advantage, increased administration, and failure to achieve corporate objectives. By performing routine plan diagnostics, a company can rapidly identify any underlying issues with their plan design and take proactive steps to resolve them and create fairer plans.

Stephen Fox Global Practice Leader Sales Performance Center of Excellence IMS Health

Tel: +1-610-238-4292 sfox@us.imshealth.com

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